How to incorporate subscriptions in trading

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AceofAce
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How to incorporate subscriptions in trading

Post by AceofAce » Mon Mar 07, 2011 12:08 pm

Hi everyone,

I am trading the turtles system 2 with good success and i will soon be adding some friends and family money into the program. The issue is how to add their subscription into the program. I can't just size up the existing open positions as their open equity will be different to the new positions open equity. Also if i set the stops on the added positions where the current stops are, ill be risking way too much of the new capital.

I can't just set different stops for the new positions and keep a tab of each one's profits on an excel table either. I run the program on a Limited Partnership account which means that new partners legally get entitled to their share of full profits from the day of subscribing (running profits and new)

Any ideas will be appreciated.

sluggo
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Post by sluggo » Mon Mar 07, 2011 1:07 pm

Here is an idea: don't even try to make the addition of new investors "seamless" or "transparent".

If you intend to begin trading the new investors' money on Wednesday, then you could exit all current positions (held by the old investors) on Monday. You could spend Tuesday counting up the amount of money you have, old investors + new investors. Also on Tuesday you could decide what position sizes and what stops you want, with this new total amount of money under management. On Wednesday, you could establish new positions (new sizes & new stops) based on this new total amount of money under management. Now you can feel very confident that you've got the correct position size and the correct stops for all investors.

Me? I personally don't like this idea. But then I don't like the Turtle system post-1996 either. You may have different opinions.

AceofAce
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Post by AceofAce » Mon Mar 07, 2011 1:38 pm

Thank you Sluggo, much appreciated.

Yes, i wouldn't go with this idea either. Closing all positions and reopening on Wednesday means that existing investors would be affected by someone elses trades (subscriptions). That would not be fair to them.

Technically I know how this can be done without affecting the old investors and the new ones getting their exact fair share of future profits. I take the acount value just prior to the execution of the sizing up. This valuation would serve to calculate how much to size up existing positions by and how much % holding to allocate to the new investor. So if the account value is say $20,000 just before sizing up positions and the new capital is say $10,000, then I size up all positions by 33.3% and the new investor would be entitled to 33.3% of all future protits.

The problem is the stops. If there are stops far away from a current price which get executed, old investors loose unrealised equity (never had it, never lost it!) whilst new investors loose hard earned capital. Setting different stops for the new positions would protect somewhat the new capital but would also disturn the performance of old investors.

This is the dillemma...

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Post by Chris67 » Mon Mar 07, 2011 2:15 pm

ace of ace
I disagree with you
on the day the subs come in - you simply size up the positions by the equivalent amount - it makes no difference at all what the open equity is on the open positions you are sizing into - from that day forth your new investors will get the same performance as the old investors - if all positions draw down from the moment you size up then so be it - you / they will get stopped out at the same rates - so for example you size up new positions on first day of month that6 new monies come in - everything dumps and you get stopped out of everything - new inverstors lose 15% and old investors lose / have a 15$ draw down - there is no way round this
If you are not careful you will go down the "bad route" of taking only those positions with lowest inherent profits - ive seen people blow up doing this before -
another example - your old investors bought crude in your system at 80 - its now 110 - new investors come in and you effectively get them long at 110 ? so what ??? if it dumps it dumps and teh fact that crude is at 110 doesnt mean it wont go to 200 ?

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Post by Eventhorizon » Mon Mar 07, 2011 2:23 pm

Ace,

I think there is really only one decision here: Is it better to scale up already open positions or should you wait for new trades to come along which you size according to the new amount of AUM. You had to make this decision the day you started trading - you went from zero AUM to $x AUM; did you immediately open all the existing positions your system said you should have, or did you wait for new entry signals to come along?

It is not germane to the decison that your new investors risk an immediate draw-down because the stops are currently further away from price than they would be when the position was originally opened.

Figure out the 2x2 grid of outcomes - one axis is Scale Up Positions / Don't Scale up Positions, the other is Current Positions Make Money / Current Positions Lose Money. You will quickly see that the decision just affects the leverage of the investors' positions, their relative outcomes are the same i.e. the gains and losses are in proportion to the ownership share of the account, they are just larger if you Scale up Positions. So it is equitable to ALL your investors to take make either choice. Thus the choice comes down to which decision has the expectation of making more money overall.

Basically if you let the new equity sit as cash, the existing investors gains / losses in the existing positions from that point forward are lower because they share them with the new investors. However, their risk is also lower as the proportionately own more cash.

My guess is, and this is supported by this blog post, that you should scale up positions with the new equity because you designed your system to work with particlar position sizes and your existing positions are more likely to be winners than losers (or you wouldn't be trading them). Some positions may be starting out at better prices than they were opened.

This is off the top of my head, so if anyone thinks I am off-base PLEASE say so.

Edit: Chris - darn it, you beat me to the punch!!!

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Post by AceofAce » Mon Mar 07, 2011 3:16 pm

Thanks to all of you.

Chris, this is the classic way how funds take money from new investors. I don't agree that its not important to value the account (open equity) prior to sizing up. How would you know what proportion of the account the new investor should own and how much to size up by.That is a function of his capital and the value of the account he is getting into just before he enters.

If the account value is $20,000 and he is bringing in $10,000 he should own 33.3% of the combined account and positions should be scaled up by the same % so that existing investors remain unaffected. Suppose just before joining, the account value collapses to $10,000 then he should own 50% of the combined and positions should be scaled up by 50% (not 33%) as he is getting in at the bottom. Positions prices have collapsed so a 50% size up and 50% ownership would leave existing investors in the same, albeit depressed position, as they were just before he joined.

My point and hence my question has more to do more with a worst case scenario. The turtles system has the chance of going up by 100% and give it all back if the Take profit triggers do not not make it above the stop loss points. What if you take an investor at the peak. Existing investors would see their account shoot by to double and then come back to where it was. Not much to cheer for but then again nothing to die for either. New investors would only see their just invested capital get halved!

This is what I want to avoid.

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Post by Chelonia » Mon Mar 07, 2011 6:19 pm

Run seperate accounts, or advise them to scale in. If they want to invest 20k, then month 1: 5k, month 2: 5k, etc.

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Post by Moto moto » Mon Mar 07, 2011 7:11 pm

ace - to help consider the issues you are talking separate things here.
they are related, but separate issues,.......given you have to collectively lump old and new investors in your case and are not running separate accounts.

1) to dilute or not dilute risk return of the existing unitholders/shareholders/partners/investors. This depends on if MODEL.

2) accounting for drawdowns/losses - this is based more on the NTA price of the fund. Once in the fund/partnership whatever..... they are sharing in the losses/profits. How much of this is based on the FUM for each client. Then go back to point 1) to see how much risk return they will share in.

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Post by Chris67 » Tue Mar 08, 2011 2:17 am

Purely from a fund perspective there is no choice but to scale up open positions
If I manage 10 Mill and an investor puts in 1 mill next month - I scale up all possies by 10% - he/ she doesnt own anypositions - he or she is an investor in the fund whose month 2 performance will now match the performance of the current investors - same applies on downside - if I mange 10 mill and collapses to 9 mill end of March then investor comes in with a buck - I scale existing positions up 10% - its the only way to keep funds performance accurate / equalisation
However if yu are saying that there is a risk of doing this and then giving back 100% of profits - then you will have a 100% draw down -- I'm not sure you should be trading this system !!! Yes individual positions may give back 100% of open P/L and a new investor may take that on chin - but if every position goes at once and you ghet stopped its a 100% D/D and thats pretty darn aggressive - presumably fund stops should operate here

I think the danger is if you do nothing with new cash and curreent investors may get pissed off if performance is watered down

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Post by rgd » Tue Mar 08, 2011 12:59 pm

I agree with Chris. There is no other option. If you scale up proportionally, everyone has the same return moving forward. Besides, I did a bit of research on a related topic when launching my strategy, 19 out of 20 times, it is best to assume the existing theoretical positions rather than wait for only new signals.

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Post by AceofAce » Wed Mar 09, 2011 1:06 am

I agree with Chris's examples, although i disagree slightly with the numbers of the second example. If the fund value collapses to 9 and a new investor then joins with 1, the fund value increases by 11.11% (1/9) so positions should be scaled up by the exact same % so current investors don't get any slippage on future performance.

Now my worry is not 100% DD, maybe i was not clear. The system I trade is very volatile, yes profitable in the long term. In the short term it can generate 100% unrealised performance (the fund doubles) and then go back down where it started ie 50% DD. if an investor koins at the peak and i scale as above, everybody in the fund will suffer the 50% DD. old investors only lost unrealised profits whereas the new investor looses 50% of just subscribed capital! Thats my point.

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Post by Chris67 » Wed Mar 09, 2011 3:38 am

Ace of Ace - your point is in fact an excellent and well thought out point !
The problem is that there is no real way around it other than what I wouild do in the situation and probably reflects a strategy that Sluggo would probably advise (If I may take the Lords name in vein for a moment) - I have a similar issue right now
I have an investor who came to me Monday this week with a afew million to invest- my system is on a huge uptick (huge relevant to what I am trying to achieve) - and it worries me that he may be getting in right before a puke (this is of course my gut feel which could well be very wrong) - so I have advised him to put half in now and wait for a pullback. This is not perfect as the system may put onother 6 months of performance before the pullback comes - but in that example he has made some money and he is in ?? so all is not lost
iVE FOUND YOU CAN NEVER GO WRONG IN this business by doing half immediately - whatever it is you are doing - that way 2 outcomes are possible 1. you get better levels to get in on the other half 2. You make money (albeit a reduced amount) - but hey there is no such thing as a perfect solution in anything right ?
Hopethis helps
C

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Post by Chelonia » Wed Mar 09, 2011 5:01 am

Exactly what i said! Scale in funds with whatever you and the investor feel comfortable. Explain to him the character of the strategy. If he commits 1 m, then 2x 500k per month, or 4 x 250 a month.

Make the investor understand the implications, and he will be more then happy to take your advise and respect you for your long term thinking.

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Post by Eventhorizon » Wed Mar 09, 2011 10:06 am

Ace, surely you can back-test this.

Why not explore what would have happened over your back test period to a hypothetical capital addition - all you need is the daily value of your total equity curve, and some estimate of slippage in adding to open positions.

Then you can provide your investors with an empirical estimate of what will happen to their capital contribution over some different time frames. e.g at the end of the first month you have a 20% chance of being up by 5% or more and a 20% chance of being down by 10% or more, after two months and so on. Then they can decide whether they would rather scale in or go all in right away.

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Post by AceofAce » Wed Mar 09, 2011 2:30 pm

Having seen all your responses, I would be inclined to opt for a mid-way solution. I trade 100% systematic (non-automated) which means I completely avoid discretion at all times. I guess I'll have to make an exception though when taking new money in.

When all my positions are pretty close to the stops, then any new money, can be added and positions scaled in with the same stops and no fear of major drawdown risk to the fresh capital.

If though some large positions have substantial unrealised profits built in and far away stops then I guess I'll have to recommend to my investor to scale in their investment to 2-3-4 lots.

Thanks again to all of you. Comments most welcome as always...

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